What is Investing, and How Does It Work?
Investing is something that many people are interested in, as they recognize that it is a practice that can supplement their income and help them to be more financially stable and independent. However, it is not necessarily something that a person can simply start doing. It requires some understanding and theory in order to get the most out of it. You might be wondering what investing actually means or how it works. This article explains the concept of investing, as well as some of the different ways you can invest.
What Exactly is Investing?
To understand the practice of investing, you also need to understand what an investment is. An investment is an amount of money that you put into something, in order to (theoretically) increase its value. Anything that has a value which can increase can therefore be an investment from the perspective of the individual. In even simpler terms, if you allocate some money to something with the intention of getting more money in return in the future, this is an investment. There are a few different ways that you can invest, generally speaking.
It makes sense to break investment down into three primary categories. These are lending, cash and ownership. This list goes into some depth regarding what these different types of investments mean:
- Ownership: An ownership investment is a kind of investment where you own something. This can be part of something or something in its entirety. This is probably what most people think of when they hear the word investment, as stocks are a type of ownership investment.
- Lending: A lending investment is a kind of investment where you lend money to a person, or institution in most cases. A common example of a lending investment is a savings account, as this accrues interest. This is because you actually lend money to the bank through your savings account, and in return, your money accrues some interest over time, becoming more valuable the longer that you leave it.
- Cash: These types of investments are those that can easily be converted back into cash, with a money market fund being a good example. They are generally not as profitable as other forms of investments, with returns usually being between 1-2%. However, the risk is often very small, so they could be a good option for someone who is extremely risk-averse and yet wants to invest.
There are also some principles of investing that are important to know in order to get the most out of the practice. Investing is something that is inherently risky, for example. Whenever you put your money into something, there is no guarantee that you can get it back. However, risk can be minimized in many different ways. Many people refer to the risk and reward principle in investing. This principle essentially stipulates that the higher the risk associated with a particular investment, the higher the potential for reward is, too.
The Different Types of Investing
As mentioned above, ownership investment is the most common type of investing that most people refer to when they talk about the practice. There are many different types of ownership investment, which vary both in how profitable they are and how risky they are. One common form of ownership investment is actually starting a business. When you start a business, you spend money setting it up and getting it in order, and this is a form of investment, as you are putting your money into the future success of the business, instead of getting something immediately in return. This is not the most passive form of investing, but it can make a person extraordinarily wealthy if they are successful in the venture.
Another form of ownership investment is simply buying a stock. In very simple and concrete terms, when you buy a stock, you have bought some portion of the company, and the stock is proof of this ownership. While it is clearly not the same as owning something outright, you are often entitled to some say in the running and administration of the company, though it is generally not used by most investors, who are most interested in the financial gains that they can make through investing. Whether or not your investment in this area is successful depends on the rest of the market that the company is in and a whole host of other factors as well.
One type of ownership investment that is slightly controversial but still widely practiced is purchasing gold. Many investment experts and theorists suggest that between 3-15% of your portfolio should be made up of gold, either in physical quantities or investments in the market. This is because gold has sustained its inherent value for a considerable length of time, and it is universally still considered to be highly valuable today. However, others argue that, as we become more and more dependent on technologies and the digital world as a species, gold is going to become worthless. This has not come to pass yet though, and gold is therefore worth considering as a type of insurance investment in case other parts of your portfolio fall through.
Real estate investing is quite a common practice, and it often involves purchasing a property and perhaps renovating it or restoring it somehow before selling it on, ideally at a higher price than it was bought for in order to have some level of profit from the venture. Many people also purchase properties and then rent them out, which also makes it a form of investment. This can be a good form of investing, as it is often independent of the effects of the stock market but generally requires a much greater amount of money in the initial stages of the investment than simply buying a stock might.
A less common but still potentially viable form of investment is the purchasing of collectibles and artifacts. This is something that requires some expertise on the part of the investor or that they consult with someone who has a great knowledge of the field that the thing they are purchasing belongs to, as it can be hard to judge whether or not something is going to be a good investment otherwise. These investments can be somewhat risky, as they tend to require upkeep and can physically depreciate over time in the same way that a house can. It is also not always easy to predict trends in terms of what is going to be in demand and what people might lose interest in.
You may also consider education an investment. While this is a little unconventional, spending money on a college education can be something that elevates you from one strata of society to another, by opening up doors for you vocationally that did not exist before. If you work hard throughout college and achieve good results in a field that is in-demand, then you are likely going to have many more opportunities ahead of you after graduation than you would have otherwise. With that being said, automation and digitalization of the workplace is rapidly changing the value and nature of a conventional college education, so this does depend on the field, and it is perhaps not as predictable as it once was. Nevertheless, a college education can certainly be considered an investment for these reasons.
Should I Invest?
Whether or not you should invest and the kinds of investing that would be best for you depend somewhat on your financial goals and current situation. However, it is advised that everybody invest in some way once they have the financial stability to begin using part of their income for such a purpose. It is generally recommended that you have a minimum of three months’ living expenses saved up before you begin to use your income for things other than necessities, so if this is not the case for you, then you should prioritize saving that up before you begin to think about investing.
Once your savings are in order, you should then think about your financial goals. In all likelihood, investing can help you to reach them in a number of ways. If you want to have a greater amount of money set aside for your retirement than you would otherwise have just through your income, then you can use investing as a way to slowly supplement your income over time. If you are looking for a way to make substantial amounts of money, then investing can also help you do so, though it involves much more risk to get such great rewards.
In order to figure out how you can make the most of investing in order to suit your needs, come up with a plan of where you want to be financially at different stages of your life. Then, you can start to figure out what type of investing is going to best suit you. For example, if you are interested in supplementing your income gradually over time, then a good idea is to invest in established companies whose income and success is stable and relatively predictable. That way, you are putting less on the line by investing in them than you might with a new company. On the other hand, if you want to make a substantial amount of money, then you might want to look into investing in new startups or swing trading, which can quickly give incredible returns if you are lucky and know what to look for. However, the risk involved in these types of investing can be too great for many.
Another thing to keep in mind when you are thinking about investing is having a diverse portfolio. This is usually advised as a way to minimize risk, because, if your portfolio is diverse, this means you have invested in different classes of assets and perhaps different kinds of investments altogether. If you do so, you are less reliant on the success of a particular industry or sector, so it is less damaging to you or your finances if a particular asset that you have invested in performs badly for some reason. It is important to strike a balance though, because a portfolio that is excessively diverse can spread you too thin in terms of time and resources, and it can potentially minimize your returns.